The average tax refund last year was more than $2,900, according to the IRS.
If you’re one of the lucky recipients, you know there are many ways to spend that cash, and we’ll cover several ideas – good and bad – in our ongoing Tax Hacks series. But if your refund is on the way, consider this before using it: There are ways to make that refund do double duty by helping out now and improving your tax situation next year.
In the video below, Money Talks News founder and CPA Stacy Johnson offers a few ideas to supercharge your next tax refund with this year’s. Check it out, and then read on for more details…
Stacy uses this strategy himself, and it paid off big last year: He picked up a $1,500 energy tax credit after investing his 2010 refund on a high-efficiency AC unit. His electric bill has been an average of $100 a month lower ever since.
While that particular credit is no longer available, there are still other options. Take a look at these ideas…
1. Alternative energy
The renewable energy tax credit available now is in some ways better than the one Stacy took advantage of last year. For starters, it’s not capped at $1,500 – you simply get a credit equal to 30 percent of whatever you spend. Plus, it applies to improvements you make to both your primary residence and second homes, although not rentals. And if you don’t want to invest in an upgrade this year, not to worry: The credit doesn’t expire until 2016.
But there is a big downside: You have to buy things that are less mainstream and usually more expensive than an air conditioner. Your options…
- Geothermal heat pumps: A heat pump that uses the ground instead of outside air to provide heating, air conditioning, and hot water. Here’s more information from Energy Star.
- Wind turbines: A turbine that converts wind energy into electricity and ties into your house’s electrical system.
- Solar water heaters: A water heater that uses the sun. Here are the models that qualify.
- Solar panels or photovoltaic systems: Solar cells that capture the sun’s energy and convert it into electricity.
Check out this page of EnergyStar.gov for the list of tax credits, which includes another option, this one capped at a $500 credit for residential fuel cells.
Depending on your situation and the age of your energy system, none of these may be practical. The improvement with the highest cost/benefit ratio is probably the solar water heater. For as little as $4,000, you can cut your monthly electric bill by up to 20 percent. In some cases, you may be able to pair the tax credit with a rebate or other incentive – check with both EnergyStar’s rebate finder and DSIREUSA.org before you buy.
2. Retirement plan contributions
Depending on your income level, contributing to your retirement accounts could be worth a credit or a deduction.
A credit is usually better because it directly reduces the amount of tax you owe dollar for dollar, while a deduction reduces the amount of your income that gets taxed. Either way, you’re also making a long-term investment that, with proper planning, will have a big payoff in the future.
If you make under $28,250 a year, the Retirement Savings Contribution Credit (also called the Savers Credit) can save you up to 50 percent of the first $2,000 put toward any of several plans, including traditional and Roth IRAs and 401(k)’s. That means a credit of up to $1,000 next year.
If your income is above that, you may still qualify for the deduction – but you have to invest in a traditional IRA before age 70. The contribution cap for this year is $5,000 (and $6,000 for those over 50) and can generally be fully deducted unless you participate in a retirement plan through your employer. In that case, your modified adjusted gross income determines the deduction, with $56,000 being the cap for a single filer to get a full deduction. Beyond that, you may be eligible for a partial deduction.
Putting $3,000 toward retirement could save you up to $1,000 next year on your taxes. Look at IRS Publication 590 for details.
3. Charitable donations
You could also donate part of your refund to charity for a deduction, although this means you have to itemize on your tax return. Although this might seem like giving away money now to save some later, you know it’s going to a good cause instead of being frittered away on little extras for yourself. And you don’t have to give up your hard-earned money: If you’re spending your refund on new furniture, for instance, you can also get credit for giving away stuff you no longer need.
Both cash and property donations made to qualifying organizations are fully deductible, with a few caveats…
- According to the IRS, if your contribution “entitles you to merchandise, goods, or services, including admission to a charity ball, banquet, theatrical performance, or sporting event, you can deduct only the amount that exceeds the fair market value of the benefit received.” In other words, the government considers part of the donation payment that you don’t get credit for, and the charitable organization can tell you how much.
- Contributions worth more than $250 require a receipt from the charity (although getting one is a good idea regardless of the amount) and those worth more than $500 mean additional paperwork. There are also special limits on deductions for those who donate more than 20 percent of their adjusted gross income.
- To make sure a charity qualifies for tax deductions, look at the searchable list of nonprofits in the IRS database. Charity status can be revoked, so just because an organization qualified in the past doesn’t mean it will in the current tax year. And it should go without saying that not all organizations are created equal – read 4 Tips to Find the Right Charity.
Bottom line? A tax refund isn’t just quick cash. With a little planning, your money can do double duty and guarantee tax advantages next year. Looking to save more on this year’s taxes? Check out 8 Easy-to-Miss Deductions.